Europe’s fund expenses
at a crossroads
The benefits of mutualizing
the cost of distribution
Executive Summary
This study analyzes investment funds’ expenses with
the purpose of identifying key cost drivers and potential
areas for cost reduction. It is based on a sample of
400 funds managed by 60 promoters established
across 6 domiciles: 2 European cross-border domiciles
(Luxembourg and Ireland), 3 European domestic
domiciles (France, UK and Germany), and the United
States. Our data was complemented with information
received from market participants who contributed to
the development of this report.
On the contrary, the second part of the report identifies
significant cost saving opportunities by mutualizing
parts of the distribution supply chain:
First, we argue that enhanced cost transparency and
investor awareness should encourage asset managers
to become more efficient and to provide better control
of expenses charged to investors. We explore two areas
of potential cost reduction:
•Under a mutualized cash processing environment,
each market player would process one payment per
value date and per currency, independently from
the number of counterparties with which it deals.
This is precisely what DTCC provides in the U.S. fund
market, and it could be achieved via the introduction
and operation of a central cash compensation
account.
•Cross-border distribution: domiciles such as
Luxembourg and Ireland, as de facto cross-border
product servicers, must handle the requirements
of multiple target markets in which their funds are
distributed. These requirements include tax reporting,
documentation filings, currency share class hedging,
KIID production, fund maintenance and setup, local
agent and audit fees.
•Supply chain management: fund distribution is a
cumbersome process, which can vary significantly
from one domicile to another in terms of efficiency.
The process includes order management, cash
processing, Know-Your-Client procedures, distributor
due diligence, reconciliations, data dissemination and
document management.
Our first section of the report confirms that specialized
cross-border domiciles are more cost-efficient than
other European domiciles when it comes to multiple
market distribution. Process efficiency, critical mass,
and experience achieved over the years play a major
role in reaching multiple markets while keeping costs
under control. On the basis of the data we reviewed,
we believe that there is limited potential for further
cost reduction in this area in specialized cross border
platforms.
2
•The mutualization of know-your-client (KYC) activities
appears as a major innovative step compared with
the current industry model. It would simplify the
“many to many” model of KYC interactions between
transfer agents and distributors/investors, enabling
a reduction of compliance cost while increasing the
speed of client acceptance procedures.
•If all orders were processed via an automated, central
ordering system, manual processing time would
almost disappear, and bilateral interface maintenance
and technology requirements would be significantly
reduced.
•Significant streamlining would be achieved if
a solution was developed to capture transfers,
pre-match counterparties’ instructions, and provide
a single-leg automated instruction to transfer
agents. Corporate actions and dividends would
also benefit from cost savings via the elimination of
paper confirmations and the reduced amount of time
required to book these events.
•Finally, if all of the above were achieved, the industry
would significantly reduce the cost of reconciliations,
the number of error corrections, and the reliance on
client support.
Combined, these above items currently cost around
€1.3 billion per year. This total could be reduced by 70
percent to €376 million per year under a mutualized
approach.
Introduction
The combined effect of cost mutualization, fee
transparency and tightened inducement rules
will eventually trigger the long-awaited
alignment of European fund expenses with
their U.S. peers
The global investment fund industry is much larger
today than it has ever been. Its European component
more than doubled in size over the past ten years,
with total assets under management surpassing the
€10 trillion mark in the course of 2015.1 Against the
background of the deepest global recession since World
War II, a major political crisis, and an unprecedented
number of regulatory initiatives, such a strong and
sustained growth emphasizes the attractiveness of
investment funds and the success of the UCITS brand.
Despite these impressive achievements, the industry
will still have many challenges to overcome in order to
secure and strengthen its growth. This report originates
from the observation that three trends will directly
impact the future success of our investment fund
model:
•The strong expansion of non-European fund
domiciles, as their share of global GDP and financial
wealth significantly increased over the last 10 years.
The development of passports and trade agreements
within these emerging regions represents both a
challenge and an opportunity for the European fund
industry.
In light of these opportunities, this report argues that
the European fund industry should both control product
expense and limit the cost of distribution. While the
former will help unlock the investment potential of
European savings (41 percent of European household
wealth is still held in cash accounts), the latter will
improve the competitiveness of investment funds
against other financial instruments. In their constant
aim to improve processing efficiency, market players
should assess the opportunity to mutualize elements
of the distribution supply chain, hence reducing costs
against the highly efficient nature of other, more
mature, asset classes.
In the general context of enhanced investor protection,
the review of the Markets in Financial Instruments
Directive (MiFID II) will drive a significant reduction in
European expense ratios, domestic and cross-border
alike. The combined effect of cost mutualization,
fee transparency and tightened inducement rules
will eventually trigger the long-awaited alignment of
European fund expenses with their U.S. peers.
•The financial requirements of an ageing population
and the need to provide cost efficient pension
solutions via well-governed, diversified and risk
managed collective investment schemes
•The public demand for increased investor protection
and systemic stability of the financial system, with
a potential growing role for non-bank financial
solutions and intermediaries
1 EFAMA Fact book, 2014
3
1. Fund fees in Europe and U.S.
Fund investors and fee levels
One of the major decision criteria for investors besides
product performance is undoubtedly the cost of
an investment solution. Whether it is in the form
of front-end loads or management fees, charges
incurred by investors can be significant. In a post-crisis
environment, transparency and comparability directly
threaten uncompetitive charging structures. A robust
and disciplined pricing strategy should therefore be a
priority for fund promoters.
A correlation between investor preferences and the
level of fund expenses has been evidenced in the U.S.,
where assets tend to converge toward funds with low
expense ratios.
US mutual fund assets are concentrated in lower-cost
funds (% of assets, 2014)
80
73
74
72
68
70
60
50
40
30
27
32
28
26
20
10
0
All equity
funds
Actively
Index equity
managed
funds
equity funds
Target date
funds
Funds with expense ratios in the upper three fee quartiles
Funds with expense ratios in the lowest fee quartile
Source: Investment Company Institute (2014)
Beyond the natural preference of investors towards cost-efficient solutions, it is a combination of market- and
regulatory-driven dynamics that will eventually influence the pricing policy of European funds.
01/
03/
4
Passive products
Strong competition
from passive investment
schemes (e.g., ETFs,
Smart Beta Funds)
Transparency
Increased transparency
in a post-crisis
environment
02/
04/
Competition
Fierce competition between
asset management firms
and increased awareness
from investors about product
fee structures
Inducements
Ban of inducements
in Europe post MIFID II
01
Passive products
Actively managed funds face increasing competition
from their passive substitutes. The trading flexibility
of exchange-traded funds (ETF) and their lower cost
directly call into question the supposed benefit of an
expensive investment selection process. According
to research conducted by the INSEAD in 2014 the
difference between actively and passively managed
schemes for comparable investment strategies reached
approximately 80 bps of the annual management fee
in Europe.
Actively managed
funds face increasing
competition from their
passive substitutes
This pricing differential becomes particularly difficult to
justify when more than 50 percent of actively managed
U.S. funds fail to consistently outperform equivalent
passive strategies.
Percentage of actively managed US mutual funds underperforming their benchmark (2014)
100
80
70
60
50
40
30
20
10
e
on
Eu
ro
z
ro
p
e
Eq
ui
ty
Eq
Fr
ui
an
ty
c
Ge e E
qu
rm
ity
an
Em
yE
er
q
G
ui
gi
ty
ng lob
M al E
qu
ar
ke
ts ity
Eq
U. uit
y
S.
Eq
ui
ty
Eu
ro
Eu pe
E
ro
zo quit
ne
y
E
Fr
an quit
y
c
Ge e E
qu
rm
ity
a
ny
Em
E
er
gi Glo quit
ng
b
y
M al E
q
ar
ke uit
y
ts
Eq
U. uit
y
S.
Eq
ui
ty
Eu
ro
Eu pe
E
ro
zo quit
ne
y
E
Fr
an quit
y
c
Ge e E
qu
rm
ity
an
Em
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gi Glo quit
ng
b
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M al E
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ar
ke uit
y
ts
Eq
U. uit
y
S.
Eq
ui
ty
0
Eu
Percentage underperforming
90
One Year evaluation
Three Year evaluation
Five Year evaluation
Source: Morningstar (2014)
5
02
A competitive Asset Management landscape
Despite a constant and robust growth in net sales,
actively managed funds charged 10 bps less in 2012
than they did in 2002. Over the same period, passive
strategies grew significantly more than active ones
while reducing annual management fees to a far
greater extent than active managers (see chart on
right page), with a price reduction of up to 47 bps
in the UK.
A commonly accepted interpretation of these figures
holds that passive funds managed to increase their
market share in such a short timeframe thanks to an
aggressive pricing policy. In response to this trend,
recent studies highlight that active managers are
reacting by further decreasing their fees and reviewing
their investment processes and pricing strategies.
In this context, it is worth noting that the ability
to reduce charges incurred by an investor is largely
enabled by ETFs’ highly efficient “creation/redemption”
mechanism and the way they gain exposure to the
market while being shielded from trading fees. Actively
managed funds are by nature condemned to pay
trading spreads and commissions each time an investor
enters the fund, hence the more limited extent of their
cost reduction potential.
Despite the differences inherent to actively and
passively managed funds , other factors may enable
active asset managers to review their pricing structure:
Internal
•Asset managers significantly improved the granularity
of fund expenses breakdown and the quality of
6
internal management information systems.
•Some asset managers are adopting enhanced
accounting systems using activity-based costing as an
essential complement to fixed total expense ratios.
By significantly improving the quality of the analytical
accounting figures and their regular monitoring, asset
managers gain a more granular understanding of their
product revenue margin. This understanding can in turn
lead to a more flexible charging structure that is able to
quickly adapt to investor sentiment.
External
•Both asset managers and their intermediaries/
distributors leverage fund processing solutions
currently available on the market, including
automated messaging protocols, electronic
data dissemination links, dealing platforms and
aggregators, etc.
•Asset managers closely monitor and regularly
review the performance of their outsourcing service
providers in line with constantly evolving distribution
setup and regulatory requirements.
These factors help to reduce asset managers’ cost base,
which provides more room to review pricing policies.
Evolution of management fees of actively and passively managed funds (%)
1,56
1,48
1,05
0,61
1,44
0,97
7
1,18
1,53
0,5
Passive
European Union
1,52
Active
European Union
Passive
United Kindom
Active
United Kindom
1,73
1,62
1,0
05
05
0,61
1,95
Active
Germany
1,85
1,96
1,94
1,45
,45
45
Passive
France
1,09
Active
France
Active
Italy
Active
Spain
2002 Management fees
Passive
Spain
2012 Management fees
Source: Insead OEE data services (2014)
7
03
Increased transparency in a post-crisis environment
The financial crisis of 2009-2012 triggered a wave of
new regulatory requirements. Investor protection is
one of the foremost goals of this legislative effort.
The legislation’s focus on greater transparency aims
to restore the confidence of investors toward financial
services.
Within the fund industry, both UCITS and AIFMD
frameworks impose strict investor protection
requirements, be it via mandatory diversification
of assets, independent depositary bank, or strict
licensing requirements. From a cost transparency
perspective, after the adoption of the UCITS KIID,
additional requirements were introduced in the MiFID
II package and the PRIIPS KID. The combined objective
of these regulatory initiatives is to improve the content
of investor information on costs and charges and
to facilitate direct comparison between financial
instruments:
2 The PRIIPS regulation will enter into force on 1st January 2017
8
•UCITS KIID:obligation to disclose ongoing charges,
among several other standardized and comparable
key characteristics for investment funds
•MIFID II
–– Detailed ex-ante and ex-post investor disclosure
on the financial instruments, on the investment
services and on the ancillary services provided to
the client
–– Explicit requirement on financial instruments
to have a coherent cost structure charged to
the investor as part of the product governance
arrangements
•PRIIPS KID2: extension of the UCITS KIID for all types
of investment products (including insurance-linked
products)
Transparency, direct comparability, and an explicit duty
not to provide misleading information to investors
intuitively create an incentive to control fund charging
structures.
04
Tightening of inducement rules in the EU
Inducements have long been a cornerstone of
European fund distribution: they reflect the basic
principle that intermediary networks must be built and
remunerated in order to reach the final investors. The
cost of these complex distribution networks has always
been borne by customers via the annual management
fees embedded in the fund charging structure. In
parallel, a remuneration was rebated to the distributors
for the service provided, usually making up a
substantial part of the ongoing charges of the fund (up
to 80 percent for actively managed equity funds).
In an attempt to protect the independence of the
advice given to end customers and to promote cost
transparency, some EU countries, immediately followed
by the EU as whole, decided to create regulations
targeting inducements. From January 2017, distributors
of investment funds will be either forced to:
•Forward the full amount of these payments
to end investors or
•Renounce to receiving this remuneration from
fund promoters or
•Renounce to their “independent” status and inform
end investors on the amounts perceived from fund
promoters
The new inducement regime will significantly impact
the charging structure of investment funds, for the
benefit of end investor. Research conducted on RDR 3
share-classes in the UK shows an average difference of
41 percent in the ongoing charges between so-called
“clean” share classes and non-RDR share classes. The
inducement pay-out percentage traditionally varies
significantly by asset class and investment strategy.
Mark-down of ongoing charges due to RDR
100%
41%
80%
60%
100%
40%
59%
20%
0%
Non RDR share-class
Ongoing charges
RDR share-class
RDR Mark-down
Source: Deloitte analysis
Whereas RDR imposes a ban on all commissions paid
to advisers by anyone other than the client, MiFID II
opts for a partial ban on independent advisers and
discretionary portfolio management. The effect on
the fund charging structure should, however, be fairly
similar, i.e., a reduction equivalent to the current level
of remuneration paid to intermediaries.
The new inducement regime will
significantly impact the charging
structure of investment funds,
for the benefit of end investor
3 RDR: Retail Distribution Review – a law targeting the ban of trailer fees in the UK fund retail market in 2012
9
Cross-border distribution
and the fund’s ongoing charges
In light of this growing pressure on costs charged
to investors, we assessed the average fee levels of
European versus U.S. domiciled funds across a sample
of 400 comparable funds representing over $500bn.4
Not surprisingly, it is immediately apparent that U.S.
domestic funds are significantly cheaper than their
European peers, including when we compare funds that
are similar in terms of size and investment strategy (i.e.,
no effect from economies of scale). The cost differential
between the 2 “regions” can reach 30 bps for certain
investment strategies.
The most intuitive explanation links the difference to
the different distribution footprint: the widespread use
of cross-border distribution in Europe has no equivalent
in the U.S. market, where funds are almost exclusively
distributed domestically. Any direct comparison
between the two domiciles must therefore take into
account the cross-border factor.
Based on the information received from market players,
and considering the structure of a fund’s ongoing
charges, we identified a common set of cost items
that can be directly attributed to multiple market
distribution. These items can be summarized as follows:
Investor transparency and disclosure:
•Production, translation and dissemination of legally
required documentation (e.g. KIID, factsheets,
prospectus, annual reports)
•NAV publication in various distribution markets
4 Our data covers UK, US, GER, FRA
5 Source: Fundsquare country registration data
10
Operations and accounting:
•Compliance and monitoring activities related to
foreign markets
•Accounting in different standards (e.g., Lux GAAP,
IFRS)
•Administration and hedging of share classes in
foreign currencies
•Increased complexity of audit review due to increased
control perimeter (e.g., multiple collection accounts)
Regulatory requirements:
•Fund registration fees
•Tax figures computation, filing and reporting
(e.g., Germany)
•Legal fees (e.g., legal opinions for foreign markets)
Assuming that Luxembourg funds are distributed,
on average, in 7 foreign countries5, we modelled
the different cost components and drivers and have
estimated the total cost of multiple-market distribution
to be in the region of 2.3 bps. This cost is mainly
composed of the following two items:
•Activities carried out within the fund administration
(68 percent)
•Activities carried our within central administration
(14 percent)
A detailed breakdown of these costs can be found in the diagram below:
Breakdown of cross-border distribution impact per cost category (bps)
0,1
Audit fees
Tax*
Governance, management
and servicing fees
0,3
0,3
Administration fees
1,6
*Local tax excluding subscription
tax which is not included in TER
Tax filling/Reporting fees
Legally required documents and communication
Other administration fees
Hedging cost
KIID production
Share class maintenance and set up
Local agent fees
Other governance, management and servicing fees
0,3
0,3
0,2
0,2
0,2
0,2
0,1
0,4
Total 2,3
When performing the same exercise for France,
Germany and UK domiciled funds, the total crossborder components of their ongoing charges
ranged between 8 and 12 bps even if the number
of distribution countries is below the average of
cross-border platforms.
These findings clearly suggest that processing
efficiency, critical mass, and experience developed in
cross-border domiciles allow global asset managers
to reach multiple markets in a cost-efficient way. It is
therefore not in this area that cross-border domiciles
should seek further cost reduction, as the potential
savings would not be material, and these domiciles
are already competitive against other European fund
centres.
Conclusion and outlook
Facing a cost-sensitive, well-informed, and protected
investor, fund managers must continuously reduce
their cost charging structure. While U.S. funds are
significantly cheaper than European ones, the first part
of our analysis observes that cross-border domiciles
(i.e., Luxembourg and Ireland) appear to be more
efficient from a cost perspective than other European
domiciles (i.e., France, Germany and the UK) when it
comes to multiple market distribution.
Since further cost savings can hardly be generated in
this area, we now turn to the activities associated with
the distribution supply chain, i.e., the steps required in
order for a fund to be distributed across a network of
intermediaries.
In our attempt to identify how the competitiveness
of the fund industry can be improved, the second
part of our report analyzes how the steps required
for distributing funds could be streamlined. While it
is widely acknowledged that the U.S. achieves a high
degree of operational efficiency and cost mutualization
across the distribution supply chain, Europe is
often perceived as inefficient due to a fragmented
distribution and servicing landscape and low levels of
processing standardization.
The second part of our report investigates this
perception and simulates the impact of a fully
streamlined operational infrastructure on fund
processing costs with a focus on the Luxembourg
market.
11
2. Cost mutualization
and fund distribution
Fund distribution activities are known for their
cumbersome requirements, especially when compared to
other financial instruments. While their intrinsic, primary
market nature is inherently complex, investors increasingly
compare investment solutions and de facto place funds in
competition against other asset classes.
Funds distributed exclusively in their home market
usually leverage the existence of established financial
infrastructure.6 These typically include central securities
depositories (CSD) and central repositories capable
of storing static data, dynamic data, and sometimes
even fund documentation. A unique set of regulatory
obligations further reduces distribution complexities.
Nevertheless, their limited distribution footprint prevents
them from achieving the size and scale required to
generate cost efficiencies. Specific share classes—
with higher expense ratios to cover for the additional
distribution costs—are usually launched whenever they
are distributed in a foreign country.
By contrast, international funds distributed across multiple
domiciles do not benefit from a single infrastructure.
A mixture of bilateral links, aggregator platforms, and
processing service providers prevail, while documents
and data dissemination are channelled through multiple
information distributors or resellers. Local notifications
must meet various national constraints, including
language translation and specific tax reporting duties.
Far from being a disadvantage, this operational flexibility
supports the growth of these international funds. The
setup of distribution networks across multiple countries
was achieved in a relatively short timeframe, with
immediate benefits from economies of scale.
In order to seize the full benefits of these potential
economies of scale, the second part of this study
aims at substantiating and quantifying the benefits of
streamlining distribution activities. Our primary objective
is to design a fully streamlined industry model and
highlight the differences with current industry practices.
We then try to quantify the cost savings generated by the
target model and highlight the model’s benefits for both
distributors and fund promoters.
A mixture of bilateral links, aggregator
platforms, and processing service providers
prevail, while documents and data
dissemination are channelled through multiple
information distributors or resellers
6 This is mainly observed in France and Germany. Other domestic fund domiciles (e.g. UK) have not fully leveraged the technical infrastructure in place for other financial instruments.
12
The following four critical statements emerge
from our analysis:
1.Orders: over the past decade, the industry made
significant efforts to automate order flows. The
results of these efforts are very positive with an overall
industry level of “straight through processing – STP” in
Luxembourg increasing from 47 percent to 77 percent
in the last 8 years. However, despite these efforts, the
remaining number of manual orders still represents a
significant cost for the industry. Our study also argues
that replacing bilateral STP links by a central order
management system would generate further cost
savings.
2.Transfers, reinvestments: statistics on order
automation do not account for other fund processing
activities which, as opposed to order management, are
predominantly handled on a manual basis. This mainly
includes transfers, dividends and corporate actions
processing.
3.Payments: the predominant practice, except for
leading and most mature market players, of executing
one payment per order and per counterparty, despite
being highly automated, has the effect of driving
volume and cost up. Netting per currency across
counterparties and transaction types would significantly
reduce these costs.
4.KYC & due diligence: regulation has tightened
requirements around KYC and distributor due
diligence. The current model where each management
company requires the same information and performs
the same checks on each distributor may have reached
its own limits.
Approach & assumptions
Our analysis is based on a cost modelling of distribution
activities, including both a distributor and a product
manager value chain. The individual components of each
value chain link were broken down into processes, for
which we estimated a cost based on assumptions and
hypotheses discussed with market participants.
FUND PROCESSING
CASH PROCESSING
• Fund data management
• Techincal connectivity
• System setup & maintenance
• Management of dealing channels
• Order management
• Client support
• Corporate actions
• Dividends
• Tranfers
• Commission payments
• Settlement instruction
management
• Payment processing
• Management of multiple
settlement models (1-2-1.
grouped & net settlement)
ERRORS &
RECONCILIATIONS
COMPLIANCE &
RECORD KEEPING
• Cash reconciliation
• Order reconciliation
• Position reconciliation
• Error corrections and
repairs
• Fund documentation
• Compliance verification
• Documentation gathering
• Account opening
• Account maintenance
• KYC documentation
• Distributor due diligence
13
We estimate the total annual processing
cost of fund distribution in Luxembourg at
€1.3 billion
The main cost driver supporting our cost model is the
number of annual transactions processed by Luxembourgdomiciled funds. We applied the following approach to
derive this figure with two “reference points”:
•We collected information from transfer agents
representing ~55 percent of the Luxembourg fund
asset base, and we extrapolated the total figure for
the Luxembourg market, taking into account the
market share of each player in terms of assets.
•We collected the total cash value of subscriptions and
redemptions7 and divided this by the average order
size per distribution segment.
Based on this approach, our estimate for the total
number of transactions for the Luxembourg market in
2014 is 28 million.
The second most important driver in our cost modelling
is the automation rate. Our assumption combines
the information collected from transfer agents with
information regularly published by industry associations
and standard messaging infrastructures.8 Based on this
approach we applied the following figures:
7 CSSF statistical reporting
8 EFAMA – SWIFT FPS Report, Mid 2014
14
•60 percent of the total order volume is currently
handled via ISO standards (SWIFT)
•17 percent of the total order volume is currently
handled via proprietary FTP formats
•23 percent of the total order volume is currently
handled manually, mainly through fax orders
Several other assumptions and parameters were used
in our model such as the total employee cost per day,
processing time for a manual transaction, volume of
transfers, error and repair rates, level of automation for
cash payments, cost of a cash payment, average number
of interfaces maintained by transfer agents, number of
significant transfer agents, number of large distributors,
etc. These assumptions were combined with factual data
such as the number of Luxembourg funds, number of
sub-funds, number of share classes, number
of management companies, etc.
Industry benefits
We estimate the total annual processing cost of fund
distribution in Luxembourg at €1.3 billion. Taking an
aggressive approach to size the total possible savings
at the level of the whole market (i.e., assuming all
inefficiencies could be overcome and converted into a
fully streamlined model), we have estimated a split of
costs and savings as follows:
Processing costs
Current (€Mn per year)
Future (€Mn per year)
Δ (in percentage)
Orders (fund processing)
450
190
-58%
Transfers, corporate actions,
dividends (fund processing)
120
20
-83%
Cash processing
170
5
-97%
KYC & due diligence
180
20
-89%
Data & documents dissemination
15
1
-93%
Errors & reconciliations
355
140
-61%
Total
1290
376
-70%
Split of savings generated through a streamlined distribution supply chain (overall)
€1,3Bn
€1,400,000,000
€1,200,000,000
€120,000,000
-71%
€1,000,000,000
€450,000,000
€800,000,000
€600,000,000
€350,000,000
€400,000,000
€200,000,000
€0
€375Mn
€15,000,000
€180,000,000
€170,000,000
Direct
€20.000,000
€190,000,000
€140,000,000
€5.000,000
€20.000,000
Infrastructure
Cash management
KYC & due diligence
Data intelligence and documents managements
Errors and reconciliation
Order processing
Transfers, dividends & corporate actions
15
If all streamlining efficiencies were achieved, the
Luxembourg industry could save up to 70 percent of its
total distribution costs. This represents €900 million of
annual savings, which could materialize mainly across 4
areas presented below.
Tackle the “residual” portion of manual orders and
reduce the cost of bilateral connections
When factored into the estimated market size of
28 million trades, and applying the above rates of
automation, the cost of processing orders in the current
industry model amounts to €450 million.
This amount can be split in two sub-categories:
•Order routing, booking and confirmation of manual
orders: despite the increase in automation rates, this
item still represents 80 percent of order processing
cost (€365 million), mainly due to the processing time
spent by transfer agents and distributors and the
resulting amount of fees charged to the funds.
•The maintenance of automated bilateral connections
via ISO standards (SWIFT) or proprietary FTP formats
represents 18 percent of the order processing cost
(€80 million). This reflects the cost of maintaining
multiple bilateral connections (i.e., updates and
releases), the cost of parameterizing share classes
correctly, the cost of SWIFT / FTP terminals, and the
cost of SWIFT messaging.
Under the assumption that all orders are processed via an
automated, central ordering system, manual processing
time would almost disappear, and interface maintenance
and technology requirements would be significantly
lower. The effect of such mutualization would reduce
the total cost of processing orders to €190 million,
i.e., a 58 percent cost saving.9
16
Split of savings generated through streamlined order
processing
€500,000,000
€450Mn
€450,000,000
€400,000,000
-58%
€350,000,000
€300,000,000
€250,000,000
€250,000,000
€190Mn
€200,000,000
€150,000,000
€100,000,000
€200,000,000
€150,000,000
€50,000,000
€40,000,000
0
Direct
Distributors
Infrastructure
Fund
It must be stressed that the number of orders and
automation rates quoted above strictly refer to
instructions arriving at the level of transfer agents.
The aggregation approach of local transfer agents, large
distributors, fund platforms and financial supermarkets
compensates for an even greater volume of non-STP
upstream orders. Short of any official statistics, these
orders are not captured in our cost model. However,
the predominant view during our interviews was that a
majority of these orders are sent manually to the local
agent appointed by the fund.
Increase automation beyond order management
Several other processing activities contribute to the cost
of fund distribution. Among the most prominent ones,
the annual cost of transfers, dividends, and corporate
actions processing equals €120 million.
Today, stock transfers represent 10 percent of
subscriptions’ and redemptions’ volumes. Automation
rates typically encountered at transfer agents and
distributors are well below the ones observed for
traditional orders with an STP rate as low as 10 percent.
Processing times per transfer reflect the complexity of
matching both counterparties’ instructions, which leads
to multiple chasings and investigations.
Not surprisingly, the manual and bilateral processing
of transfers between distributors and transfer agents,
estimated at €95 million per year, constitutes by far the
biggest portion of these processing costs. The remainder,
equally distributed between corporate actions and
dividends processing, mainly results from the manual
booking of notifications and corporate actions events.
Split of savings generated through transfers,
dividends and corporate actions
€140,000,000
€120Mn
€120,000,000
€100,000,000
€80,000,000
-83%
€70,000,000
€60,000,000
€40,000,000
€22Mn
€20,000,000
€50,000,000
€19,000,000
€3,000,000
€0
Direct
Distributors
Infrastructure
Fund
Significant streamlining efficiencies would be achieved if
a solution was developed to capture transfers, pre-match
counterparties’ instructions and provide a single-leg
automated instruction to transfer agents. Corporate
actions and dividends would also benefit from cost
savings via the elimination of paper confirmations and the
reduced amount of time required to book these events.
If all the above streamlining efficiencies were
implemented, the industry could save up to 83% of this
cost component. This represents €97 million that would
benefit both distributors and funds.
17
Cash netting with a central compensation account
is the way to achieve the highest rate of payment
compression
•Orders sent to the transfer agent are bundled per
transaction type (subscription vs. redemptions), per
currency and per value date. An estimated 30 percent
of total payments follow this model.
Under the current industry model, market players adopt
three approaches to settle fund transactions:
•Orders sent to the transfer agent are netted per
currency and per value date, leading to one payment
per currency, per day, and per counterparty.
The remaining 10 percent of total payments follow
this model.
•Each order sent to the transfer agent leads to
a corresponding payment (in the “one-to-one”
settlement model). Approximately 60 percent of total
payments follow this model.
Distributor
Order
Management
Transfer
agent
02
03
‘Grouped’
settlement model
Net
settlement model
One-to-one
settlement
Grouping per
transaction
type
Netting per
counterparty
em
ptio
ns
s
scr
ipti
on
Red
s
ion
ipt
Sub
scr
s
on
Cash
Correspondent
Bank
Cash
Correspondent
Bank
ns
ptio ns
scri
io
Sub empt
ed
&R
Sub
Cash
Correspondent
Bank
pti
em
18
Cash
Correspondent
Bank
Red
Cash
Correspondent
Bank
Sub
& R scriptio
ede
mpt ns
ions
01
‘One-to-one’
settlement model
Cash
Correspondent
Bank
Although the second and third models reduce the
number of settlement instructions, they remain
“counterparty-driven.” In an ideal world, each market
player would process one payment per value date and per
currency, independent of the number of counterparties
with which it deals. This is precisely what the NSCC
infrastructure provides in the U.S. market, and it could
be achieved via the introduction of a central cash
compensation account.
Net settlement model via central c ash
compensation account
MARKET
INFRASTRUCTURE
Distributor
Order
Management
Transfer
agent
Netting
across all
counterparties
Cash
Correspondent
Bank
Cash
Compensation
Account
Cash
Correspondent
Bank
19
Considering the cost of SWIFT messages used to issuing
and receiving payments, fund settlement processing in
Luxembourg costs €160 million per year. Following the
effect of volume compression, via the use of a central
cash compensation account, the same activity would
cost €3.5 million to the industry. These savings assume
that all payments settled in the main currencies—EUR,
USD, CHF, JPY and GBP—would be eligible for the central
cash netting service. A residual number of payments for
settlement denominated in other currencies would still
have to be performed on a bilateral basis.
Split of savings generated through centralized
cash management
€180,000,000
€170Mn
€160,000,000
€140,000,000
€120,000,000
-97%
€90,000,000
€100,000,000
€80,000,000
€60,000,000
€40,000,000
€80,000,000
€20,000,000
€4,000,000
€0
Direct
Distributors
20
€5Mn
Fund
Infrastructure
€1,000,000
Mutualize KYC and distributor due diligence
procedures
The financial sector witnessed increasing international
and local regulatory pressure for anti-money laundering
(AML) and know-your-client (KYC) measures and controls.
Increasing on-site visits from most national regulators
reflect the higher level of public scrutiny and expectations
around the controls and procedures to be implemented
by all professionals and the willingness of the asset
management industry to be a role model within the
financial industry.
Against this background, fund distribution is performed
increasingly within a global landscape, aggressively
targeting new (emerging) markets. Cross-border fund
promoters target distributors across multiple countries.
In turn, distributors develop open architecture strategies
that lead them to set up agreements with multiple fund
promoters. This interconnected environment inevitably
leads multiple fund promoters to request KYC documents
from the same distributors. The same inefficiency occurs
when fund promoters need to perform due diligence on
a distributor.
Today’s industry model therefore involves a significant
amount of duplicate requests received by distributors
from all the fund promoters with whom they are
involved. A mutualized approach, whereby a single
request of documents could be shared across fund
promoters, would be highly beneficial to both distributors
and to the fund industry. A similar approach could be
adopted for due diligence procedures, whereby a single
due diligence and its observations could be used by the
fund promoters’ community.
The benefits of setting up a mutualized approach to
KYC and distributor due diligence are intuitive:
•Have a single point of access for up-to-date and
verified KYC documentations, reducing the processing
costs at industry level
•Minimize operational costs while increasing the
quality and consistency of controls
The financial sector
witnessed increasing
international and local
regulatory pressure for
anti-money laundering
(AML) and know-yourclient (KYC) measures
and controls
•Shorten time-to-market to onboard new
counterparties (account opening process)
•Make a single request for documents towards the
distributor, instead of individual requests per fund
promoter
•Maintain focus on core business activities and get
rid of non-core activities, particularly in the case
of management companies and distributors
21
22
Today
Indirect
investor
Tomorrow
TA 1
Distributor 1
TA 1
Distributor 2
TA 2
Distributor 2
TA 2
Distributor 3
TA 3
Distributor 3
Distributor 4
TA 4
Direct investors
TA 5
• Multiple points of truth for documentation
• Redundancy of controls
Inefficiencies and risks
Contrary to the previous savings categories, KYC
responsibilities cannot be outsourced so simply. Under
the current regulatory regime, the fund management
company and the transfer agent are deemed responsible
for correctly fulfilling this requirement. Such an innovative
model of centralized KYC therefore requires a strong
willingness from market players to enter into robust
contractual agreements.
One possible approach would consist in the appointment
of the provider of KYC and due diligence services by
the management company. The execution of controls
would be outsourced to the provider under the joint
responsibility of the management company and the
transfer agent. A delegation agreement must therefore be
formalized between the provider and the management
company, and a robust contractual framework should
enable the transfer agent to keep control and comfort
while decreasing operational workload.
Indirect
investor
Distributor 4
Direct investors
Infrastructure
Distributor 1
TA 3
TA 4
TA 5
• Single point of truth for documentation
• Shared operational services
• Harmonized and systematic controls
Operational efficiency and better
risk management
Contrary to the
previous savings
categories, KYC
responsibilities cannot
be outsourced
so simply.
23
ManCo delegates distribution of
shares/units
ManCo
ManCo delegates Subs/Reds
and Share register holding
ManCo delegates KYC
Investors
Distributor
In charge of the
collection of
application documents
Transfer Agent
In charge of Subs/Reds
and Share register holding
& AML transaction monitoring
Infrastructure
In charge of KYC process:
• Documentation repository
• Watch list and reputation
risk management
• Risk scoring
• Reporting
Acceptance of this set up from the national regulator
and the financial intelligence unit (FIU)9 would be an
additional step in the process, as the provider would
have the obligation to obtain authorization and to report
suspicious business relationships.
Ultimately, this approach would enable market players
to focus their efforts on the development of key
differentiating offerings while relying on a trusted
counterparty for daily KYC activities. It would rationalize
the current “many-to-many” model of KYC processes
between transfer agents and distributors/investors,
enabling a reduction of compliance cost and increasing
the willingness to accept new business relationships.
While several activities would remain under the remit of
management companies and transfer agents (e.g., client
acceptance, account opening, transaction monitoring,
etc.), the following services could fall under the scope of
a KYC mutualized solution:
Natural persons
SLA
Legal persons
Documentation repository
•Collection, archiving and maintenance (e.g., expired
identity documents, authorized signatures) of KYC
documentation
•Identification, verification services, and ongoing
monitoring
•Flexible data acquisition process (parameters, lists)
•Counterparty unique identification
•Centralized access to enrichment databases and
business intelligence capabilities
•Compliance with data privacy legal requirements and
data protection standards
Watch list and reputation risk management
•Screening against sanction, PEP and blacklist checking
•Reputation risk through bad press monitoring
•Ad-hoc updates of watch lists
•Filter settings parameterization features, case
management, and reporting
9 National agency responsible for receiving, processing, analyzing and disseminating information relating to suspect
financial transactions to enforcement agencies and foreign FIU’s
24
Alert management
•Alert management based on decision trees and
agreed upon procedures
•Complementary investigations if needed (ad hoc)
Split of savings generated through centralized
compliance functions
€200,000,000
€180Mn
€180,000,000
Risk scoring
•Scoring platform:
–– Risk scoring service supporting
–– Individual parameterization set (risk weights).
Alternatively, standard parameterization should
be provided
–– Individual acceptance matrix to categorize
counterparties (new or existing)
–– Delivery and maintaining risk scores by
counterparty
•Due diligence on intermediaries
€160,000,000
€140,000,000
€120,000,000
€100,000,000
€80,000,000
€60,000,000
€40,000,000
€45,000,000
€20Mn
€20,000,000
€15,000,000
€0
Direct
Reporting
•Internal management reporting
-89%
€135,000,000
Distributors
€5,000,000
Infrastructure
Fund
•Files for regulatory reporting / declarations (national
competent authority, financial intelligence unit)
Archiving:
•Conversion and electronic archiving of KYC
documentations
Considering the average number of shareholders
per management company, the ratio of distributors
requiring an enhanced due diligence, the effort required
to complete a due diligence, and the KYC processing
requirements, we estimate the total KYC cost of fund
distribution in Luxembourg at €180 million per year.
Under a mutualized solution, even without assuming
a higher level of processing efficiency, the mere
replacement of the “many-to-many” scenario by a central
provision of KYC services would translate into an overall
cost of €20 million per year, i.e., a 70 percent decrease
from the current situation.
25
Conclusion
Finally, the fund industry should reflect
on the opportunity to mutualize KYC
and distributor due diligence activities
In line with the overall ambition to contain fund
expenses, Luxembourg fund promoters should consider
4 immediate actions to save up to an impressive €900
million within the industry:
•Automate the residual portion of manual orders and
review the opportunity to maintain bilateral STP links
against the adoption of a central ordering system
•Push automation and process mutualization beyond
orders to include highly manual processes such as
transfers, corporate actions, and dividend processing
•Limit the number of payments by netting settlement
flows through a central cash compensation account
In addition to the significant cost savings previously
presented, the above three actions would substantially
reduce the cost of reconciliations, the number of error
corrections, and the reliance on client support. Combined,
these items currently cost €355 million per year. With
these actions, this cost would be reduced by 60% to
€140 million per year under a mutualized approach.
Finally, the fund industry should reflect on the opportunity
to mutualize KYC and distributor due diligence activities.
Even if the ultimate responsibility of these checks should
remain with management companies and transfer agents,
this report demonstrates that mutualizing them would
generate significant savings: up to €160 million per year.
Bibliography
- Cremers, M., et al. (2015). Indexing and Active Fund Management: International Evidence. Working paper,
University of Notre Dame, France.
- Davydoff, D., Klages, M. (2014). Study on the Performance and Efficiency of the EU Asset Management Industry.
Working paper, Insead OEE data services, France.
- European Fund and Asset Management Association (2014). Trends in European Investment Funds – 12th Edition.
- Morningstar (2013). Global Fund Investor Experience - 2013 Report. Morningstar Research Papers.
- Philips, C. B. et al. (2014). The case for index-fund investing. Vanguard Research Papers.
- The Investment Company Institute (2014). Fact Book: Mutual Fund Expenses and Fees. Retrieved June 2015,
http://www.icifactbook.org/fb_ch5.html
- Commission de Surveillance du Secteur Financier (CSSF), Statistical Reporting, various years.
- European Fund and Asset Management Association (EFAMA)–SWIFT FPS Report, mid-2014.
26
27
Contacts
Benjamin Collette
Partner - Global Investment Management
Consulting Leader
+352 451 452 809
[email protected]
Dominique Valschaerts
Chief Executive Officer
+352 28 370 580
[email protected]
Sergio Venti
Director - Strategy & Corporate Finance
+352 451 452 626
[email protected]
Olivier Portenseigne
Chief Commercial Officer
+352 28 370 409
[email protected]
David Berners
Manager - Strategy & Corporate Finance
+352 451 454 252
[email protected]
Paolo Brignardello
Head Product Management and Marketing
+352 28 70 528
[email protected]
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